Tuesday, July 31, 2007

Reader's Journal and Dow-Oil Ratio

At long last I have updated Reader's Journal. The range of topics covered by readers is amazing and fun to read; as a bonus, there are several book and film recommendations, and thoughtful ideas galore. Here is a quick listing:

Michael GoodfellowIncome InequalityHistory of Transportation, The Pursuit of Glory (book)

Fred RoperParallels between 1929 and 2007

MegaThe 70s Redux: oil shortages, rising crime and more

Zeus Y.Black Swan, what we already know but are desperately trying to escape

Albert T.Struggle between capital / labor, inflationary pressure

HelenThe Crude Awakening

Riley T.Soylent Green

FastwaterTheology and self-serving government

There are three important essays: One on the a priori connection between cheap oil and cheap food, another on The Great Unraveling, and an incisive satire from ever-reliable satirist Protagoras skewering Total Quality Management (TQM), the bane of large organizations.

Said the grasshopper to the ant, winter is but a once in a lifetime event and hence improbable. (Hang on, can the title be longer than the haiku?)

first frost of autumntouches the butterflies wingonce in a lifetime

Lastly, we puncture the heavily-hyped illusion so beloved of foaming-at-the-mouth TV pundits--that the Dow Jones Industrials reached a "new high" in value rather than in just name-- with a chart submitted by frequent contributor Harun I.

This charts the ratio of the DJI and light Crude oil. Note that when oil was cheap and the DJI high in 1999, the ratio spiked. Thought the DJI is much higher in nominal terms, we can see that in terms of purchasing power of energy, it is pathetically low.

Monday, July 30, 2007

Conventional wisdom holds that real estate declines are slow, orderly trends which unfold over many years. But could the housing market be as primed for a "Black Swan Event" as the stock market?

Let's look at a chart of the last housing decline, circa 1990-1996, courtesy of Lee Williams and the California Housing Forecast. The light-blue line traces the 17% decline in San Diego housing in that 7-year period, as reflected by the Case-Shiller Index. The dark blue line traces the current housing bust's decline. (Lee William's detailed article on Housing Affordability is posted on Schahrzad Berkland's excellent California Housing Forecast.)

"This year, almost 1 million people nationwide will enter a stage of foreclosure, according to RealtyTrac.com. That great tidal wave is ravaging the already beleaguered real estate market and causing repercussions from Wall Street to Washington, D.C.

In the second quarter of this year, 2,206 homes in the nine-county Bay Area were lost to foreclosure, according to real estate service DataQuick Information Systems. That was the highest number for this area since DataQuick started tracking foreclosures in 1988, and an almost nine-fold increase from 258 foreclosures in the April-June period last year. Also in the second quarter, DataQuick said 7,696 Bay Area homeowners received notices that they were in default on their mortgage payments -- the first step in the foreclosure process. That was more than double the 2,910 default notices received at the same time last year. "

The popular book (recommended here by U. Doran) by Nassim Nicholas Taleb The Black Swan: The Impact of the Highly Improbable describes how amazingly often supposedly unlikely events occur in the real world. Risk cannot be banished forever; at best it is driven into hibernation. Just as we are seeing a re-emergence of risk in global stock markets, it appears that an "improbably rapid" meltdown in the housing market is underway.

The factors triggering a landslide of NODs and foreclosures are gathering momentum with every passing day:

1. Fixed-rate mortgages have climbed to 6.70%. This is a far cry from the bottom rates of 5% of a few years ago. The jump from 5.2% to 6.7% may not look like much, but it's a jump of 29% --a staggering increase in the cash needed every month to service a mortgage.

2. Fewer borrowers qualify for the best rates. In the above S.F. Chronicle story, one self-employed borrower re-financed his initial loan. His new rate: 10.5%. Rather than track the "best rate" being advertised, perhaps we should be tracking the "real rate" desperate re-financers are accepting as credit tightens.

3. Real rates being offered to borrowers and those trying to re-finance are steep. The difference between 6.7% and 10.5% is 3.8% -- a staggering 56% premium over the headline rate. That translates into a payment which is $19,000 more per year on a $500,000 loan. ($52,500 - $33,500 = $19,000)

4. The focus on subprime borrowers glosses over the HELOC homeowners (home equity loans) who are underwater. As one of the cases in the above story illustrates, homeowners who extracted most of their home equity in the belief that the rise in their wealth was never-ending are discovering that the sag in house prices has dropped them underwater. As their home equity loans re-set, they find they can no longer afford their once-affordable home.

5. Prices are dropping much faster than statistics reflect. Another case described in the S.F. Chronicle piece describes a property which was appraised for $630,000 in January that now has a "real time" market value of about $455,000.

6. Buyers at the peak in 2004-5 have hung on as long as they can, and are now capitulating en masse. As crazy as it sounds to those of us from an earlier era, buyers with incomes of $2,600/month willingly accepted mortgages with payments of $2,600/month--not including taxes and insurance. By working weekends, borrowing, etc., many of these buyers have managed to make these back-breaking payments for a few years. But now the well has run dry, and they are falling off an unavoidable financial cliff.

As my notes on the chart suggest, there is a generational element to these waves of default and foreclosure. Generation Y (those in their 20s) have no memory of the last downturn in the early 1990s, so they were quickly caught up in the get-rich-quick, housing-never-goes-down mania of the 2000-2005 period. Buying with no money down and accepting "liar loans" with equanimity, they are the first to bail out. Lacking any equity and with few prospects for jumps in wages gigantic enough to cover their rising payments, the decision to get out is painful but unavoidable.

The next Black Swan Sighting will occur next year, when Gen-Xers start losing their jobs. Those in their 30s are cushioned from the sudden decline in values by virtue of their buying into the housing market earlier, in the late 90s and dot-com bust era (2000-2003). The fabulous increases of 2004-5 left buyers on the Left and Right Coasts with enough equity to ride out declines, and time to re-finance out of adjustable-rate loans into fixed-rate mortgages before credit tightened.

But Gen-Xers are heavily dependent on high-paying jobs. Once one spouse loses a big-bucks job, the debt-bomb starts ticking. As the economy sink rapidly into a long-delayed, deep recession, job losses will decimate wage-earners' ability to keep up huge mortgage payments.

Gen-Xers' parents are very much alive and kicking, and facing their own financial woes (see below), so unlike the older Baby Boomers, Gen-Xers can't hope to inherit a fortune or a free-and-clear house to save them. They will cling on as long as possible, hoping to find jobs which pay the same as the ones they lost, but when that search becomes futile, then they will be forced to liquidate/sell en masse. This will trigger another Black Swan decline in housing.

The Baby Boomers have the equity, but as they lose their health insurance and suffer health issues, they too are being forced into bankruptcy. This unexpected process is already playing out nationally, as Boomers juggle helping their parents and offspring while their own health suffers the usual slings and arrows of advancing age.

The Boomers are in a triple vise: they are as dependent on high-paying jobs as Gen-Xers, and even less likely to find replacement jobs as the recession lays waste to the U.S. economy. Many have spent freely of their equity (via home equity lines of credit -HELOCs) even as they counted on the ever-rising equity in their homes to fund their retirement. A single health crisis--or a health crisis in a parent--can be a tipping point which pushes the family into a financial slide which leads to foreclosure or bankruptcy.

As retirement looms, even healthy Baby Boomers start realizing their retirement dreams are fading as housing drops. Just as in the stock market, you can watch profits vanish for only so long, and then you sell to retain what little is left. This panic selling by soon-to-retire Boomers will trigger the final Third Black Swan decline.

The notion that 76 million Baby Boomers can all sell their primary residences to the following generation of 40 million at sky-high prices... do you see a wee disconnect here? If you examine U.S. demographics in the broadest terms, it becomes abundantly clear that housing will be in over-supply for decades to come. Yes, there will be immigration, but less as the recession dries up employment. And most immigrants are coming to work in low-paying jobs; they will not be buying a Manhattan condo or a Santa Monica bungalow or even a McMansion in Phoenix.

As these demographic realities become visible, the rush to the exits will become a stampede, making the resulting drop far deeper and faster than anyone expected. Many Baby Boomers rushing to cash out already own a second or third home purchased in the bubble; they have no need to buy another home. So as their main residences flood the market, raising inventory ever higher--who's going to be buying these millions of houses and condos?

For those who wish to explore generational and demographic issues further, I recommend The Fourth Turning (recommended by correspondent Matt)

And speaking of Black Swans, here is haiku from reader/contributor Allan J.

Bears laugh, Bulls crythe Black Swan wingsland rough sea

jagged graph downlightning jag upwind blows old

the dashes, the flashesthe tears, the glimmersthe nerves of fists

my oil house coldour country closet barewar nags our children

hearts darken, adrifteyes burn to seehistory quivers voice

Thank you, Allan, for these thoughtful verses. I am also grateful to frequent contributor Bill Murath for his kind words on the Haiku which has graced these pages:

"It is so cool that in amongst all the economic and political essays you can throw in Haiku as a topic and then have numerous readers contribute some excellent pieces. I will not add much more since this is meant as a sincere high five, but I was just thinking that of all the blogs I read not one could pull this off.

Most excellent!"

I must credit longtime correspondent UKC (our first UK correspondent way back when) for the brilliant suggestion of eliciting Haiku from this site's creative, erudite, witty readers. Thank you, UKC, and thank you, readers.

On an unrelated topic: I have a gut feeling that the stock and credit markets are about to experience a "black Swan Event," i.e. a supposedly "impossible/improbable" decline of epic proportions.

Frequent contributor U. Doran recommended The Black Swan: The Impact of the Highly Improbable by Nassim Nicholas Taleb some months ago, and though I have yet to get a copy, I gather the basic premise is that outlier events which are supposedly unlikely happen quite regularly, and it is such "improbabilities" which largely drive human history.

This is fundamentally the thesis of a book I have often recommended here, The Misbehavior of Markets, in which mathematician Benoit Mandlebrot explains that risk--i.e. of large, statistically improbable declines in markets--cannot be massaged away with statistical models of hedging. The reason is that markets are fractal geometries, and therefore linear statistical models simply don't work in predicting market activity.

Then there's a little thing called luck, which may finally be running out. The Powers That Be which have reaped such enormous financial and political gains from the past six years of essentially bogus (read borrowed) "prosperity" have had an unprecedented run of luck: no attacks on the homeland, a quiet hurricane season last year, an uninterrupted flow of cheap money via the yen carry trade, a willing Chinese central bank soaking up $1 trillion in U.S. debt with nary a whimper of protest as the dollar loses a third of its value--all extraordinary trends of amazing fortune. (pun intended)

Could the PTB and the Plunge Protection Team's run of stunningly good luck be coming to a natural end? After all, nothing lasts forever. The possibility that the yen carry trade may suffer an abrupt unwinding is addressed by blogger Karl Denninger over at the Market Ticker blog (well worth reading), and by Gary Dorsch in DEJA VU, SPIKE RALLY IN JAPANESE YEN SPOOKS GLOBAL MARKETS (thanks to U. Doran for submitting this article).

Could another Gulf hurricane be the catalyst for oil to jump from $77/barrel to $80/brl? Or might it rise to $80 - $100 just on global supply/demand imbalance alone? Whatever the cause, the PTB won't be able to spin a happy Euphorestra-induced story about it.

Others have pointed to the rise in the VIX volatility index and many other technical indicators to suggest a reckoning is finally at hand; U. Doran sent over this excellent summary Bearish Divergences Abound by Frank Barbera.

While common sense suggests a slow, rocky decline in the markets into seasonally troublesome October, my seventh sense (even more unreliable than my sixth sense) is quivering with a premonition that the markets aren't going to be "rational" and wait for October. That may well be a Black Swan circling higher and higher in a gyre, no longer heeding its frantic Masters' urgent commands.

Friday, July 27, 2007

Readers sent in three more Haiku which capture the end of the stock market's global euphoria with uncanny artistry:

Tim H.

Summer vacationFools and children do not heedThe approaching storm

Fastwater

Dog days, summer's here.Markets wobble, credit fears.American dream.

UKC

"It's never different this time"

the flying stone laughsskips and splashes without carethe water will wait

Frequent contributor and fellow blogger Fred Roper sent in this stunning example of mindless euphoria. Countrywide Financial (CFC) is the nation's largest mortgage outfit. The company has been hyped by moronic pundits for months. But if we examine what insiders are doing, we note insiders sold $700 million of their own stock and purchased a grand total of $73,000. As Fred noted: This is a buy signal, right?

I have recently been discussing long cycles, and the potential for a severe crisis in the U.S. around 2021. Based on three long cycles now in motion, I believe one outcome of the 2021 crisis will be the end of entitlements--both the payments, and the mindset of "I deserve this."

Before you gag on your coffee/tea/water, take a look at this chart of the Federal government's own rosy predictions:

Recall that 76 million Baby Boomers, fully 25% of the U.S. population, begin drawing Social Security in 2008, and Medicare in 2011. According to this article, there will be 54 million retirees tapping Social Security and Medicare in 2020: The jolt of boomer retirement is headed our way.

According to the Bureau of Labor Statistics, the civilian labor force is currently about 153 million. On the face of it, even with little job growth, we should still have 3 workers for every retiree in 2020.

But the assumptions this is based on are faulty.

1. Medicare costs are skyrocketing, with no counter-trend in sight. As I have reported before, "Medicare program costs have risen from $70 billion in 1985 to $162 billion in 1994 to $390 billion in 2007 and are estimated to rise to $500 billion in 2011." U.S. Healthcare: Two Reports from the Front (February 1, 2007).

At this rate of growth, Medicare will exceed all Pentagon/Defense spending in just a few short years, and will dominate all Federal spending by 2021. This growth is clearly unaffordable, unless we stop spending on virtually every other Federal program except interest on the National Debt. Please see my other recent entry on Medicare, Medicare Waste--50%? (January 24, 2007)

2. Global competition is a huge challenge to U.S. productivity and job growth. Globalization is still in its infancy as a trend, and the notion that the U.S. economy can add tens of millions of jobs and luxuriate in ever-rising productivity gains for decades to come is at best suspect.

Much of the vaunted "job growth" since 2000 has been in money-churning, essentially unproductive fields such as real estate, mortgage generation and Wall Street financing. Most of the rest has been in construction (now fading fast as the nation wakes up to extreme overbuilding) and retail (filling up thousands of new retail outlets with clerks). To claim that these trends are sustainable is quite a stretch.

3. The 20+ year credit cycle has turned. Money will now become dearer for the next 17-20 years. Credit cycles tend to run about 17 to 23 years in length, and interest rates have slowly been rising since late 2003. That suggests rates will rise, perhaps slowly, perhaps quickly, for at least another 14 years--in other words, until the key year of crisis, 2021.

The U.S. has sustained the insane growth of Medicare and Iraq/GWOT (global war on terror) by borrowing trillions of dollars from non-U.S. entities. As the credit cycle turns, this borrowing will rise in cost, becoming unaffordable as the rising interest costs squeezes all other spending.

Consumers and businesses will also find new borrowing increasingly prohibitive, and as a result consumer and business spending will be curtailed--not for a month or two, but for 15 years.

As Medicare costs rise at 10%+ per year, no amount of plausible job and/or productivity growth can keep pace. Employment and productivity have tended to rise at 2% a year, but there are no guarantees that this trend can hold for the next 15 -20 years. It is also possible that rising competition, borrowing costs and the decline of the money-churning economy will result in 2% annual losses in jobs and productivity.

Predicting long-term trends is a tricky business. Most trends change course unexpectedly, and predictions based on the recent past turn out to be faulty. Can we really rely on the spectacular gains in wealth, productivity and employment from 1982-2006 to continue unabated for the next 15-20 years?

I would suggest counter-trends are already in force which will lead to the opposite: a decline in wealth, productivity and employment which will lead to a fiscal crisis by 2021. We as a people will have to come to grips with the harsh reality that we cannot afford the entitlements which were promised.

I would also suggest that a cultural change may occur in the value system of the nation, a change in which people throw off the overweening sense of entitlement which pervades our culture, and embrace (because they have no other choice) self-reliance and self-responsibility.

Thursday, July 26, 2007

Euphorestra Side Effect Alert

Pharmaceutical Safety alert! This site has just learned that Astra-Zastra's new drug, Euphorestra, has a terrible though long-delayed side-effect: after one year of completely blocking reality, the drug rapidly loses effectiveness, dropping the hitherto complacent, sunny customers into a sharply disconcerting world they have lost the ability to cope with: Reality.

Even more disturbing: the drug was widely used by our stock market and political elites, who are now finding Euphorestra no longer blocks out a shockingly dismal reality. We've all noticed an incredible disconnect from reality over the past year: the unceasing ascent of highly risky speculative markets, the descent of the dollar and the astonishing insistence by our elected Administration that there is light at the end of the tunnel in Iraq. (Isn't that what people report as they near death's threshold? A brightening light?

The list of insane denials of reality goes on for pages: that the subprime loan meltdown is contained, that derivatives such as CDOs lower risk for investors, etc. etc. etc. But let's take a look at the official Astra-Zastra Euphorestra ad:

Looking ahead to the near future, as the U.S. economy spirals into a recession the likes of which few of us have seen, I would suggest the following ad to the marketing mavens at Astra-Zastra:

At least the puzzling euphoria of our financial markets and tone-deaf politicos can now be explained--and there is some small comfort in knowing the bullet-proof denial of reality has a pharmaceutical cause. After all, many were beginning to question the sanity of those claiming absolute absurdities, such as "this administration supports a strong dollar."

Maybe that's why it's dropped 33% in value since late 2002? If this is "supporting a strong dollar," I'd hate to see what a weak-dollar policy looks like.

But it is troubling that Astra-Zastra found such willing volunteers for this powerful medication amongst the ranks of our financial and political elites.

Judging by the role call of those wolfing down Euphorestra by the handful (sorry, the list is restricted due to privacy concerns), it would seem our leaders actively sought some fantasy or drug-induced relief from the realities they spawned and nurtured for the past seven years.

The withdrawal is apparently as vicious as the one visited on working-class addicts of crystal meth (ice), another euphoria-inducing drug with a horrible letdown.

Reports of breakdowns and sobbing fits in the most elite corridors of power are becoming alarmingly common. It seems many of those in the top ranks of our elites--including those guiding our government and those in the shadow government of hedge funds, military contractors and the like--actually believed the poppycock their handlers fed them (along with heavy doses of Euphorestra) about the outstandingly wonderful unassailable strengths of the U.S. economy and its place in the world.

As if all this wasn't disturbing enough, it now appears that the leaderships of other nations from Denmark to China have also been soothing their angst with black-market Euphorestra.

This suggests that when the wheels have undeniably fallen off the rickety U.S. economy, the world will be ill-prepared to deal with the resulting reality. It is cold comfort to finally grasp why the Chinese leadership has continued buying stupendous quantities of depreciating dollar-denominated bonds--they're in a Euphorestra-induced happy-happy daze.

Skeptical of Euphorestra's early effectiveness? Take at look at the chart of Amazon.com, once and again an Internet stock darling with outrageously high price-earnings ratios:

Wednesday, July 25, 2007

Bite-Sized Poetry

Poetic gods rejoice--readers sent in more wonderful Haiku for our reading pleasure. For those left cold by Haiku, we return to our regularly scheduled unpredictable gumbo tomorrow.

What I like about Haiku is the challenge of squeezing complex emotions and thoughts into bite-sized poetry. You can read Haiku in just a few seconds, but the imagery and meanings reverberate long after. Of the masters, I like Ryokan best, but who cannot like Basho?

Here are readers' contributions, in order received:

Kenneth M.

Biblical Summer (8 linked Haiku)

Bumblebees sniff/hopspoons of vanilla ice creamfly away, dripping...

Epic winds don't blownews down avenues. A pendetonates cities.

Impeachment speechesecho off limestone. Dollarslose the glam of green.

No sky for the catto lose its cry in. Hymns arehummed in beggars' cups.

Tonight, the world couldend. We've come a long way sinceround stones and slingshots.

Greg

silver and gold coinscapitalist ships burningplundering begins

Doe Lo

the reeling mind acheswaits for beginning of endmad snake bites his tail

weary head in handcries out for much needed restknowing end is far

hope is running thinthinner water runs clearerclear to the ending

Renee S-J.

Just came across something interesting at work today. Management put out a bar graph showing our annual freight tonnage, inbound and outbound from 2002 thru 2006.

Peak was the year 2004, a combined tonnage of almost 300,000 dollars. 2007? So far about 65k. Ouch!

i work at a factory which has been operating since 1896. We do vinyl, plastics, etc for automtive interior trim, construction, pool liners and the plastic sheets used in Dentist X-ray packets. (The little ones that go in your mouth) among other items. In honor of such a drastic slippage in tonnage, here is my haiku:

Thank you, Bob K. ($20), for your kind and generous support of this humble site. I am greatly honored by your donation and by your readership. All contributors are listed below in acknowledgement of my gratitude.

NOTE: I will be away from my desk through Tuesday so email response time will be delayed --thank you for your patience! I am reading all email at night but unable to respond until Wednesday.

Friday, July 20, 2007

Longtime contributor Chuck D. recently sent in a thoughtful analysis on the interplay between food supply, development, soil and oil:

"I don't know how far out you have planned this week's theme, but you might want to consider doing a segment on the insanity of our food supply system. For example, how insane is it that we:

1. Have a food chain system that in the age of peak oil financially subsidizes agricorp busnesses over encouraging the small farmer, uses high energy production and dellivery techniques (read: oil based -- fertilizers, farming equipment, food processing and delivery systems) to supply us with 3000 mile Ceasar salads?

2. Distorts the market mechanism for grain by creating an artificial demand for corn to produce ethanol. This has a number of side effects. Anything that uses corn in food production becomes more expensive, and with the ubiquitous use of high-fructose corn syrup this includes a lot of what we eat. In addition, because we now have to divert wheat to feed cattle and pigs it goes up in price, and so does our bread and pasta. And we may go through our last 6 inches of topsoil in the Midwest to do it. All so we can make a product that is at best a break-even item in terms of input of energy units required to produce it versus energy units produced by it, and, ahem... well, maybe buy some votes with this policy?

3. Find it cheaper to import basic food necessities such as wheat gluten from China instead of making it ourselves so our bread isn't hard as a rock, and then surprise, surprise... we find out it's tainted with pesticide because China doesn't have the same quality control standards we do which run up the production costs supposedly in the name of safety?

4. Have developed out of existence much of the farm land that sat close at hand outside of cities, and which traditionally supplied the people in those cities with their food. In an age of cheap gas and happy motoring, no one cared and there was too much money to be made. But in an age of peak oil it may be different. Worse, if it is different, we have both stripped away the topsoil and compacted the ground for this development. If/when the suburban model fails, we simply can't get rid of the now useless development and put it back into farming. We may end up with wasted, useless land we can't do anything with at the same time we have people going hungry in nearby cities with no way to feed them. "

Thank you, Chuck D., for these insightful comments.

Another reader earlier this year described the same issue, that soil is a resource which cannot be scraped away, covered in compressed gravel and concrete, then exposed to air and expected to grow anything useful. Like air and water, soil is a resource which a market economy cannot value correctly. I have covered this before and recommended The Tragedy of the Commons, the seminal paper by Garrett Hardin which described the failure of the market to value/price common essential assets, i.e. "the commons."

The coming shortage of oil--i.e. the gap between the limited supply and insatiable global demand--is addressed by two Wall Street Journal articles, one in April and another in July, which was sent in by frequent contributor Michael Goodfellow. (Note that an online subscription is required to read the WSJ archives, but you can read the 7/16/07 story in a library.)

The International Energy Agency warned Thursday that output by the Organization of Petroleum Exporting Countries had hit its lowest level in over two years on production outages and self-imposed cuts, a factor likely to drain global oil stocks in the coming months.

In its monthly oil market report, the agency, the energy security watchdog for the Organization for Economic Cooperation and Development, highlighted unexpected product-led reductions in world oil stocks and what it described as "astonishing" demand growth in China, where it was forced to revise up its growth expectations for this year.

"It is a hard truth that the global supply of oil and natural gas from the conventional sources relied upon historically is unlikely to meet projected 50% to 60% growth in demand over the next 25 years," says the draft report, titled "Facing the Hard Truths About Energy."

"In geoeconomic terms, the biggest impact will come from increasing demand for oil and natural gas from developing countries," said the draft report, a copy of which was reviewed by The Wall Street Journal. "This demand may outpace timely development of new supply sources, thereby pressuring prices to rise."

The study, which was requested by U.S. Energy Secretary Samuel Bodman in October 2005, was conducted by the National Petroleum Council, an industry group that advises the secretary.

The conclusions appear to be the first explicit concession by the petroleum industry that it alone can't meet burgeoning global demand for oil, which may rise to as much as 120 million barrels a day by 2030 from about 84 million barrels a day currently, according to some projections.

My own study of the subject (admittedly an amateur's research) suggests petroleum output is maxed out at 85 million barrels a day. New supply only replaces what is being lost in declining supergiant fields. The idea that the earth can produce 120 million barrels a day of petroleum is pure fantasy, on the level of hoping the Martians arrive bringing a techno-miracle to save the day.

The only solution is to use the planet's remaining petroleum much more wisely and efficiently than we do now.

Michael also recently sent in this piece on a technology which would use much less oil--an example of many alternative technologies which are under development that could radically cut petroleum demand:

For a darker view of the slide down the slippery slope of Peak Oil, I highly recommend glancing at Life After the Oil Crash. You may find it far-fetched, as it refuses to concede technological fixes will actually enable the current global industrial and transportation complex to continue on more or less "as is." This is definitely worth reading, just to spark your own thinking on the long-term consequences of Peak Oil.

Thursday, July 19, 2007

Insanity and Complacency

Maybe you've had this experience, too. You start talking about the coming Great Unraveling / Depression and your friend/relative looks at you with an odd expression, e.g. "this guy is nuts." Since I have friends all over the country, as do many of you, no doubt, I know this isn't a California phenomenon.

Regardless of where they live--Virginia, Massachutsetts, Florida, you name it--real estate is fine, sales are positive and prices are stable or still rising. Ditto the economy. Everyone I know (other than you, dear readers, who I have met via the Internet) is absolutely complacent about their personal lives, the nation and the planet. Sure, there are problems, but there are always problems; so what's different?

What's different is the supreme complacency at the Wintry end of a long cycle of history.

I have written about various cycles recently, and knowledgeable reader Matt S. was kind enough to recommend a book on just such a long cycle: The Fourth Turning by William Strauss and Neil Howe.

Before we get to the book, let's consider an example of the insanity/complacency disconnect which was submitted by frequent contributor U. Doran: BOSTON'S CRUMBLING ECONOMY. The writer of the piece just walked around his central Boston neighborhood, snapping photos of all the retail and commercial spaces for rent. There are 30 such photos.

I have commented in the past on the hollowing out of our local downtown--not just local businesses, but chains: Eddie Bauer closed a few years ago, and now a huge Barnes & Noble bookstore has closed. How can the stock market be hitting new "highs" (see yesterday's entry) while bricks and mortar America is filling with empty storefronts "in these prosperous times"?

I know the standard answer is the stock market is weighted to companies like IBM and Coca-Cola which reap most of their sales and profits overseas. In other words: the U.S. can be a garbage heap of consumer debt and local financial ruin, and the market will be lovin' it because the Global 500 don't need the U.S. consumer to make scads of money.

Perhaps. But since the U.S. is still 30% of global GDP, and virtually every overseas "powerhouse" (Germany, Japan, China, etc.) is an export-based economy (i.e. depending on selling to someone overseas rather than to their own citizens), all of those overseas companies and workers still depend on the U.S. consumer for their pricing power and profits.

So the dragon eats its own tail. IBM is making big bucks selling to non-U.S. corporations who are prospering from selling to the U.S. consumer and to the EU. and Asian exporters, because the E.U. and Asian exporters are ultimately prospering by selling to the U.S. consumer. Any way you slice it, it all comes back to the 70% of the U.S. economy (20% of the entire global GDP) which is U.S. consumer spending.

I won't go into a long economic explanation here, but please note that if you lose 10% of your sales, and your competitors lose 10% of their sales, then you've all lost pricing power which means you've lost profitability. The global supply chain has been pared to the bone, so forget "cutting production and transportaion costs." Those are both on the rise globally. This is why the global economy will roll over when the U.S. consumer rolls over: the domino effect of non-U.S. workers, governments and exporters ultimately depending on sales to the U.S. for their profits and pricing power.

So the argument that the U.S. consumer and retailer can dry up and blow away without affecting the global economy or U.S. corporate profits (rising double-digits for 5 years running, with no end in sight!) is simply unsupported by data.

Here's what Matt had to say about The Fourth Turning:

"As for the 4T, the basis for the theory is pretty simple - as the oldest people in a society die off, most of the wisdom and experience they have goes with them - thus people tend to make the same decisions and mistakeds over and over again (history rhymes idea). And the cycle length is generally around 80 years, what the authors call a saeculum, the length of a long human life. Each of the 80 year cycles get split up into 20 year generations, so we have the GI's (now leaving life ), the Silents - born from around 1925 to 1945, the Boomers, the Gen Xers, the Millenials (another round of GI's) and now the Homelanders (another round of Silents).

Around 15-20 years before a 4T Crisis, you generally have an 'event or series of events" (what the authors call the Catalyst) which presage what the issues of the Crisis will be. In the case of WWII, I think WWI (a fairly minor war for the US) & the Great Depression definitely set the conditions (thru the Versailles treaty) that led to WWII. Likewise I think it's pretty easy to see that 9-11 and the Iraq War are easily the issues that could lead to a much bigger conflagration down the road.

IMO 911 and Iraq clearly have at their heart : OIL. And with Peak Oil raising it's ugly head, I would say this is the foundation of what is to come.

I could go on and on ... :) If you DO end up grokking the 4T - I would also highly recommend a site which I think a grand total of 5 people on the internet :) has read - Peter Savich's 'The People Vs. The Corporations'. I think it is a worthwhile addendum to the 4T theory and explains a lot about what is likely to occur over the next decade or so as the 4T Crisis approaches."

The book's authors make a strong case for an 80-100 year cycle of human history which ends in a transformative crisis. In American history, the cycle's eras are:1781: American Revolution1861: American Civil War1941: World War II2021: an unknown equivalent crisis which changes U.S. history in a profound manner

I have described the Kondratieff cycle, which suggests a financial/economic bottom around 2012-2014, and The Rhythm of War which suggests an alignment of cycles in the decade 2020-2030. I have also noted how post-bubble stock markets tend to have a "echo bubble peak" seven years after the initial bubble bursts (1929 - 1937, 1966 - 1973); after this echo bubble bursts, a long period of malaise/declines kicks in. (see charts below)

I agree with Matt that peak Oil and the global jockeying for declining resources (oil, water, food) could easily set the stage for a global conflagration around 2021. I would add the potential for war between China and Taiwan and between Pakistan and India as possible flashpoints.

I recommend checking out The Fourth Turning (at your library, if they own a copy) for a thought-provoking and sobering "long view" of American history and the coming two decades.

Though the mainstream financial press and cheerleaders don't mention it, note that the stock market bubble blew up in March 2000. Add 7.5 years and you get September 2007 as the bubble-echo meltdown target. But never mind history; this time it's different, and we're in a 20-year cycle of prosperity and permanent low interest rates. Oh, and housing has bottomed, and there's never a better time to buy anything/everything than now.

Wednesday, July 18, 2007

"The graph of 'Square feet retail space per person' you're displaying in your blog is misleading. The numbers refer to Shopping Center Retail Space per person, not Total Retail Space per person. If anything it shows that Europe is more cozy, featuring many smaller stores.

I did a quick search and only turned up a 2005 white paper that mentions on page 5 that U.S. total retail space is about 3 times larger than English total retail space per capita (wow, still really high, but more believable). You might want to ask for better numbers from your readers."Thank you, Keimpe, for drawing a distinction between shopping center space and retail space that was lost on me. In my defense, I can only say that if you drove through Fresno it seems entirely plausible that the U.S. does indeed have 7-10 times the retail space of our Western confreres.

On to the critically important topics of the day, which was suggested by astute reader Bob K: (emphasis added)

I saw yet another headline today about the new DJIA record high. I may not be phrasing this adequately, but I hope you get my drift...I am fortunate enough to have some 401K and IRA investments but these new record highs do nothing for my daily cash flow, i.e. the cost of gasoline, milk and orange juice alone are negatively impacting my budget but this new record today helps not at all. So why should I care about the new index records? And how many people are really positively impacted 'now' by the new record, i.e. who sees any benefit today in their checkbook?

And then another thought occurred to me... As I glean from your sight, particularly this week, it ain't all rosy out there, and your readership knows that. I apologize for my ignorance, but here is the question: "Who is the "they" that are causing the index to rise? And why is the market rising?" My fear is that all of this focus on the stock market, and the resultant subliminal message to 'buy - buy - buy because the DJIA hit a new high' has absolutely nothing to do with my daily economic reality.

I hate to sound like a conspiracy theorist, but are 'they' ignoring all the issues such as you have pointed out this week just to jack up the DJIA and therefore 'they' must be benefiting from this run up somehow?....although it seems to me like it is all a house of cards."

Frequent contributor Harun I. submitted a chart of the correlation between the Dow Jones Industrial Average (DJI-30) and oil (light crude). The high spike at the market's 2000 top means that a share of the DJI bought a great amount of oil. The low mark in 1985 meant that a share of the DJI bought very little oil.

As you can see, the current "new high in the DJI" buys far less of the most essential industrial commodity than it did in 2000. By this measure--in terms of a tangible non-discretionary commodity, oil--the Dow's "new high" is singularly unimpressive.

As for manipulation: knowledgeable reader David M. contributed an insider's understanding of the incredibly shaky foundations of the CDO market. (emphasis added)

I used to be a programmer for one of the mega-investment banks - its a household name, top 3 or 4. I did some work for the business unit controllers (similar to accountants) for the CDS (credit default swaps) at the company. This was 3 or 4 years ago and the business in CDS trading was growing like crazy.

One of the controller's jobs was to carefully watch the traders and that included marking (independently pricing) their positions periodically, which was extremely difficult to do. Unlike stocks and bonds, there is no public market for these securities and no reliable service to mark the value of the securities.

For stocks and bonds, there are the public markets and services such as Reuters and Bloomberg, which collect price information about stock and bond prices and distribute it to subscribers.

The CDS market is illiquid and not public and the controllers at this company subscribed to a service which provided CDS marks, but they were extremely unreliable. Why? Because the CDS traders at the firm knew the people that ran the CDS marking service! And I'll quote the controllers: "they went out for beers together after work". In other words, the marking service was getting their marks from our firm's traders!

To summarize, the firm couldn't even confidently mark their own positions in CDS. So it is impossible for anyone else that bought these securities to reliably know their value. As a result, you will now better understand the derivatives crack-up when it occurs. "

In other words: the guys selling the CDS to unwary clients are telling the guys who are supposedly establishing the value (mark to market) "objectively" what the derivative is worth. Talk about the fox guarding the chicken coop. If this isn't an informal conspiracy to defraud the unwary investors buying highly risky securities, then what is?

So when the MSFM (maninstream financial media) trumpets the "free market" and derides "conspiracy theories", feel free to gag, shred the paper or throw something at the TV. The MSFM is in fact part of the conspiracy, for their glib assurances are part and parcel of maintaining the illusions and lies at the very foundation of the CDS/CDO markets.

As to why would anyone join in such a deception--look no further than the record profits being booked by Morgan Stanley, Merrill Lynch et. al. The fees being generated by cooking up and selling CDOs and other derivatives are immense, in the tens of billions of dollars annually. That's a powerful incentive to keep the game fixed and running. It's 3-card monte on a trillion-dollar scale.

Correspondent/blogger Fred Roper sent over a comment by Winston Munn on the Big Picture blog which suggests the "marks" (unwary investors) are getting wise to the scam:

"Underwriters are affected already, having to pony up for some of the riskier corporate bonds no one is willing to buy.

"Those looking to raise money to finance the recent private-equity deals are getting a front-row view of the turbulence. Just months ago, there were more than enough eager buyers of the bonds and loans sold to support highly leveraged takeovers. But now investors are pushing back, demanding higher rates and protections from risk.

In some cases, investors are asking for so much that the bond offerings never even make it to market. ServiceMaster Co.'s underwriters called off a $1.15 billion sale of junk bonds earlier this month after investors balked at provisions in the bonds that would have let the company cover some of its interest expense by issuing more debt.

That forced the lawn-care and pest-control company to obtain a bridge loan directly from the underwriters. A $2.85 billion loan issue still needs to get done as part of the $5.5 billion takeover by private-equity firm Clayton, Dubilier & Rice and others, according to KDP Investment Advisors Inc."

Harun also sent in a chart of the dollar/oil ratio, which reveals that in terms of purchasing power, oil is far more expensive than it was at the (inflation-adjusted) nominal high in 1990.

Harun's commentary suggests another reason for the large-scale manipulation which is pushing the stock market to nominal highs, even as the purchasing power of our currency (the dollar) is plummeting to new lows: the great, abiding fear of our current political leadership and their financial cronies that the 3-card monte fraud will blow up before they leave office. (emphasis added)

"In 1998 it was thought that LTCM would bring the world financial system down due to a liquidity crisis. But we have forgotten the lessons. LTCM thought it was well diversified against the risk to which it was exposed, and in a normal market they were essentially correct.

What their models couldn’t handle was the fact that during a crisis uncorrelated issues become perfectly correlated, and so they watched all of their positions move against them during the Russian default as everyone panicked. The last sentence of the above quote is simply the lesson LTCM taught us, a lesson we will soon revisit.

The more I read and study, the more I am becoming convinced that hedge funds are effects and the causality lies with fractional reserve banking and a fiat monetary system. Debt must be expanded or the system implodes, but the growth in debt is not linear, it has to be exponential and therefore is inherently unstable.

The efforts to maintain the appearance of stability are unequivocally criminal. There is but a small number of people focusing on this but when things go critical there may be greater focus by larger numbers (a central bankers worst nightmare).

For example, how is it that during the greatest bull market in our history the dollar has been in a 22-year Bear market relative to Light Sweet Crude Oil? This is not a supply/demand issue because prices of crude stayed in a relatively narrow band during this time up until 1999 (see attached chart). The dollar has been losing its value but apparently few are interested as to the “why”.

We had better awaken because implicitly, the dollar will go to zero. Personally, I speculate there is a quiet panic going on at high levels of government. Panics arise when people are fearful and don’t know what to do. I would also speculate that the current administration has put the word out to not let things blow up on their watch, which means if the democrats win, they will get the blame.

One thing that bothers me terribly is that hedge funds are private placement, only the wealthy “sophisticated” investor can participate. This regulation is required by law. Our government feels that only the wealthy are smart enough to understand the risks involved in these funds and because of their wealth can sustain a substantial or complete loss of their invested capital. The general public cannot partake, but in a crisis it is the unsophisticated, not-so-wealthy taxpayer that provides the relief needed to save the ‘system’. This (bailouts) runs contradictory as to why the funds are regulated to wealthy investors.

This parasitic subsidization of the wealth's failed financial adventures by the middle class and poor has not caused social unrest yet and perhaps never will but nevertheless it should cease because in reality it results in a forced transfer of wealth (stealing?) from the middle class and poor to the wealthy. The “Greenspan put” should be called the “taxpayer put”. If our financial system can be destroyed by a few large firms then we must question who is really in control of this systems, the government or banks and financiers?"

What's striking about this imbalance is that European cities have plenty of retail. If you wander around a city like Paris, you'll find ground floor shops are the norm along major streets. Even small residential streets near thoroughfares support neighborhood shops. Walking down a side street in the 16th Arrondissement (near the Exelmans Metro station), you find a small grocer, a bakery, a cafe, a tabac and a larger grocery store. Just a block away, the Avenue de Versailles is lined with restaurants and small retail; an open-air "farmers market" operates every morning on a small plaza.

There is no shortage of retail space in European cities, nor shopping opportunities, and so you have to wonder if the U.S. really needs 7 times more retail space than Europe.

As for over-building, correspondent S.S. submitted this apt observation:

"Funny you should mention "mall after mall" on your trip. My 14 year old son even noticed all the empty strip malls going up in the SW Chicago suburbs. He calls them "space available malls."And lest you think this insanity is only a U.S. phenomenon, correspondent Mega filed this report from the U.K.:

"Not just America for MEGA shopping mail projects, here in Liverpool building is busy! WE are rebuilding the city centre to make one of the biggest shopping centres in Britain.... Just as everyone is switching to shopping on line/overseas!

Also we built loads of Apartment blocks....We call them flats....which nobody wants!

Only tonight one of our pop stars (Ex) was raided by a gang of thugs who smashed their way into said apartment and robbed her and her boyfriend. For years people have been queuing up to buy rebuilt flats from areas of Liverpool you NEVER want to be in. One block (where I used to buy drugs from) is in the middle of a "Free fire zone"....Yet they are now talking of £1 Million flats!!!!

Or....You could buy 170 miles away in deep country side a very nice period home, in 5-10 acres of land almost ZERO crime, nice people etc for half that!....Go Figger!

Today I had YET another sale lit drop on my table at work wanting me to buy industrial units (Workshops)....Everyone went out and bought land and built Shops, Workshops, Flats etc.... without wondering about the market. Now with Oil rocketing thus inflation (yes they can't hide it now) rates are going to rocket.

Recession, I bloody well hope so!"

I would also like to offer a first-hand account of living in a "gated community." Despite the desperate pleas of her three surviving children, my Mom bought a brand-new house in a gated community near Phoenix, AZ about a decade ago when this "self-selected imprisonment" trend really started to take off. (Your kids--what do they know? Nothing!)

Although her decision mystifies us to this day, I think she "bought into" the propaganda that this was a "safe place" that locked the big bad world outside; I also reckon she was seduced by the amazing square footage being offered (a mere three bedrooms in those misbegotten days; now you get four or five, which is astoundingly better.)

On our first visit to this middle-class American Heaven--at least that is how it was presented-- my Mom's first action was to notify Security about our car. The problem: it was parked in the driveway. This is unsightly, and therefore verboten. (There were no exclusions offered to Jaguars or other luxury vehicles, so it was very evenly enforced.) However, residents with visitors were allowed a few days grace.

Next: ah, it's evening, let's take a walk. Hmm, there are no sidewalks. The vast stretches of pavement are for vehicles only. So we walk in the street, spotting a very few other residents walking their dogs or getting a bit of exercise. After passing block after block of carefully manicured front yards with no evidence of human habitation or individual character--you were proscribed from doing much more than posting a name placard or hanging a wind chime--we reach the Community Center.

This was a truly Orwellian touch, for there was almost no one there but paid staff. Now it is true that many units in this subdivision were owned by Sunbirds, folks from Northern climes who only live there in summer, but the sales reps had carefully noted that the place was sold out and mostly occupied by fulltime residents.

What greeted us inside the "Community Center" was a vision of the lonely corner of Hell. Though Sartre was undoubtedly correct in observing "Hell is other people," (from the play No exit), this description only covers the ghetto districts of Hell, where miscreants are either shouting angrily or breaking into your house, crazy people are mumbling and cursing at all hours, pathological criminals are wandering around at night stabbing people--in other words, my urban neighborhood here in sunny carefree California.

But there is another corner of Hell, the Lonely Quarter. Here, a large, lifeless room with a bar and overstuffed chairs is devoid of life. True, the television is on, blaring the current mind-numbingly idiotic offering of a 24-hour sports channel, and a tired potted palm clings to life in its glazed pot, but the only occupant of the cavernous space is a lone elderly man, sitting alone at a table. He may be watching the TV, or staring off into space; it's hard to tell. But my spirit sank into the deepest gloom at the scene, for this was the exact opposite of Community.

Yes, there was the requisite bulletin board neatly announcing various classes and outings which had been scheduled by a paid staffer: a painting class, an exercise class, etc. But did any unsalaried resident care whether you lived or died? No one would even know you were dead or alive. You never saw your neighbors, much less got to know them, as there was no human activity in the "community" other than these artificial "community events" at the "commuity center."

The "community" had all the charm of a low-security prison, which is basically what it was. My Mom sold out for a loss a few years later--of course the developer was busy building Units 5 and 6 across the 8-lane highway, so supply always exceeded demand--and moved to Sante Fe.

Consider by way of contrast a company town. We happened to pass a company town on our camping trip, one established by a large electric utility decades ago for the employees of its hydo-electric plant. A company town must be livable, lest your employees flee. This town had a single street of well-tended houses, and a school and a general store. It was a small town, no more than a few hundred residents, roughly equivalent to a gated subdivision, but the feeling was the polar opposite of a lifeless gated Hell: people were out washing their truck, or tending their yard; it was a lived-in place, not a place tended by paid staff and inhabited by unseen owners.

Developers don't build communities--they build secure blocks of dwellings. There is a difference between the two, conceptually and in the lived-in experience. I hate to disillusion those of you who have bought in a gated community, but they are not communities, and therefore they are fundamentally sad, artificial places.

I lived in a company town as a teenager: Lanai City, island of Lanai, State of Hawaii. The company: Dole Pineapple. It was and remains a very livable community with an actual center. You know who your neighbors are because you see them on a daily basis, and know what kind of vehicle they drive, and you see them at the high School basketball game (go Pine Lads!) or in the store or post office. (There's no mail delivery, so you will go to the post office.) You will notice if someone is ill or out of town, and you will ask or be told without special effort. You won't necessarily like your neighbors, but you'll be friendly, and you'll pitch in for the reason that they are neighbors.

We in America have busily constructed countless lonely corners of Hell, and told ourselves it is Heaven. But being told a lie, and believing a lie, is not the same as living a lie.

Monday, July 16, 2007

Am I Crazy, or Is America Crazy?

I went camping this weekend, and on the way through California's Central Valley (our destination being a remote section of the Sierra Nevada) I passed shopping center after shopping center in the last stages of construction. I managed to snap a photo of one outlet I thought summed up the "healthy consumer demand" and "strong retail sector" I keep reading about:

Traveling north of Fresno, we passed block after block after block of new/under construction retail--the new "premiere" shopping destination for Fresno called River Park. Fresno is a major population center, with about 440,000 residents in the city and surrounding suburbs. Also note that its per capita income is $15,010, rather solidly in the lower-middle of California cities. The average per capita income in California is $22,000.

Fresno has a long and proud history, and I am not suggesting it doesn't deserve a square mile or two of premiere retail heaven. What I am questioning is whether any moderate-sized metropolitan area of about 400,000 moderate-income residents can support the largest concentration of retail outlets in the known world.

Yes, I am not kidding. River Park stretches on for city block after block, with more being built across the street and around the corner. Stores of particular note: Bar-Be-Que World and Vitamin Superstore. Both were huge. Need another $1,000 6-foot long BBQ grill? Of course you could buy one at Costo, Wal-Mart, Home Depot or a million other places, but don't you want to shop at a superstore that's ALL BBQ?

Ditto for vitamins. Sure, you can buy them discounted over the Internet, but why not drive across town for the on-hand selection which duplicates the aisles of Walgreens, Longs, Rite-Aid and thousands of other outlets?

I think you get my drift. There is no way that Fresno can support this concentration of retail outlets. And this is just north of Fresno; of course new retail is going up south, west and east of Fresno, too.

On the way into the suburbs, we passed one vast gated community after another with names like "Opus One" in fancy script by the heavy security gate. Opus One? Excuse me, Maestro, where do you live? "Why, M'sieur, of course I reside in Opus One, in a quaint, charming little six-bedroom McMansion."

Lest you think I am exaggerating, real estate development billboard after billboard pronounced "up to six bedrooms." Now you may have a real passel of kids, say, five or six, or have your folks and an aunt living with you, and need six bedrooms; but I suspect the demographic of buyers does not include many 7-person families.

Apparently American home builders and developers haven't heard that the boom is over because large pieces of California's enormous Central Valley are nothing more than one vast sprawling construction site.

Take the pleasant little town of Patterson. You pass it on I-5, deep in farm country, far from any urban source of employment. America's big national home builders are going nuts in Patterson, throwing up hundreds upon hundreds of new houses. This is a town of 20,000 people, folks, a small rural farm-based-economy town with a charming Main Street and few major employers. Can such a town absorb hundreds of new homes per year?

It seems unlikely, to say the least. Retirees? No slam on Patterson, but it's not near recreation, or major hospitals or the other things retirees presumably seek access to. Commuters? No way. It's several hours to any major concentration of jobs.

As I drove through this bizarre alternative-world of frenzied construction and the paving over of some of the best soil on the planet for soul-less, strikingly ugly McMansions and stucco boxes crammed cheek-by-jowl (so that 4-foot sideyard of dead weeds renders each a "single family dwelling") I had to wonder if I was insane, and I've missed the reality, which is the lending/building boom is in fact sustainable for decades to come, or if America is insane--insane to pave over beautiful, irreplacable farmland with crappy, poorly designed and built boxes doomed to be ghost towns in a few years, insane to build and sell these lifeless faux-communities far from any nourishment and insane to buy such impossible-to-cool-except-with-gargantuan-expenditures-of-fossil-fuels houses in the middle of what is essentially a desert fed by the largest artificial river system in the world.

Friday, July 13, 2007

1893, 1929, 1973, 2007: Echoes of Rolling Thunder

Let's start a re-cap of the week's theme--the Great Unraveling--with a brief look at The Panic of 1893:

"The Panic was the worst economic crisis to hit the nation in its history to that point. The National Cordage Company (the most actively traded stock at the time) went into receivership as a result of its bankers calling their loans in response to rumors regarding the NCC's financial distress.

A series of bank failures followed, and the price of silver fell. The Northern Pacific Railway, the Union Pacific Railroad and the Atchison, Topeka & Santa Fe Railroad all failed. This was followed by the bankruptcy of many other companies; in total over 15,000 companies and 500 banks failed (many in the west). About 20%-25% of the workforce was unemployed at the Panic's peak."

Hmm, calling in loans, 1893, calling in busted CDOs, 2007... and did you notice the 40-year cycle of recession/depression? 1890, 1930, 1970, 2010.

Let's look at the similarities between then and now:

1. 1893: Massive debt-fueled speculation. Railroads and other speculative ventures (yes, they overbuilt railroads in the late 1800s, just like they overbuilt the Internet in 2000) were all financed with debt-- heavily leveraged debt. No money down, no assets, just paper and promises. Sound familiar?

2. 1929: Massively leveraged speculation. In the Roaring 20s, you could buy $1,000 worth of stock with only $100--a 10% margin requirement. Now, CDOs and other derivatives are leveraged 10 times or even 20 times. A drop of only 5% in the underlying security/mortgage/bond thus spells ruin for the 20X leveraged derivative.

3. 1970: Rising energy costs, deficits and inflation, war, stagflation. The "guns and butter" policies of the late 60s and 70s (paying for a horrendously expensive foreign war and a global Cold War, while lavishing massive Federal entitlements on millions of citizens) created unprecedented deficits and inflation which despite various manipulations (the Feds started the bogus practice of "core inflation") began to run away from policy makers and consumers alike until interest rates were ratcheted up to 16% in 1981.

The oil shocks of 1973 and 1980 sent energy costs to multiples of previous costs--just as oil has risen from $10/barrel in 1998 to $74/barrel today. This combination of inflation, spiraling energy costs and business cycle slowdown created a decade of malaise and stagflation.

4. 1970s: Nowhere to hide for investors. The 1970s were a decade of decline for both stocks and bonds, especially when adjusted for inflation. Real estate faired better, as did gold, as "tangibles" were viewed as hedges against a sinking dollar. However, with the World's Greatest real estate bubble now deflating, real estate is not the "undiscovered hedge" it was in the 70s.

Now let's look at what's different:

1. Peak oil. The supergiant fields which supply most of our oil are in permanent decline. The "deep ecologists" and oil geologists who forsaw the Peak of U.S. production (Hubbert's Peak) in 1969 were roundly mocked as the last of the planet's large fields were discovered in the late 60s: The North Sea, Alaska, Nigeria and West Africa. Since then, no supergiant fields have been discovered, despite billions spent in exploration.

I had to chuckle (wryly) a year or so ago when the stock market leaped on the news that a 100-million barrel field had been discovered in the Gulf of Mexico. Nice, but that's only five days' worth of this nation's oil useage. At 21 million barrels a day, even a billion-barrel field is only 16 months of oil. And it takes a decade to drill and pump the field.

Now as the North Sea, Saudi Arabia and Mexico decline despite all technological fixes, we're facing a global Hubbert's Peak. Resource analyst and correspondent U. Doran has kept us well-informed on this development; please glance at the links in these previous entries for more:

The deficit for May rose to $60.04 billion. The deficit with China rose to $20.02 billion, the biggest imbalance in four months. So far this year, the deficit with China is running 17.2 percent ahead of the pace set last year when the overall deficit soared to an all-time high of $233 billion.

So far this year, the overall deficit is running at an annual rate of $709 billion, down 6.5 percent from last year's $758.5 billion, which marked the fifth consecutive year that the deficit set a record.Nice, but the year is still far from over. Many observers have noted over the past five years that no economy has sustained trade deficits of 5% of GDP or more for long--yet the U.S. continues to run current account deficits well north of 5%. Will the chickens of imbalance and debt ever come home to roost?

3. A sinking dollar. As I write, the Dollar Index is poised at 80.65, just a whisker above the drop-dead technical support level of 80, having dropped from 83 just a week ago. As the book The Dollar Crisis: Causes, Consequences, Cures explains, any huge, structural trade imbalance as we have today eventually gets resolved by a sharp devaluation in the currency. This rather common-sense analysis leads many to predict that the dollar will have to fall to 60 or so--a 25% devaluation from its current value--to begin correcting the yawning imbalance between imports and exports.

And lest you fall for the hype about rising exports: let's do some simple math. The U.S. imports about $1.7 trillion, and exports about $1 trillion annually. The Commerce Department reported both imports and exports rose by 2%. That means imports rose by $34 billion, and exports rose by $20 billion--meaning the trade deficit just widened by $14 billion. Just to stay even, exports have to rise about twice as fast as imports. Reality: 1, cheerleeaders: 0--again.

4. Generational war. As yesterday's entry outlined, retirees (defined as those old enough to qualify for Social Security and Medicare entitlements) are about to begin a war of attrition with taxpayers (many are both, of course, but if your entitlements far outstrip your tax bill, you're going to vote your bennies.)

Either the taxpaying generations quietly swallow huge tax increases to fund the Baby Boomers' vast entitlements (see yesterday's entry) or they rebel, forcing some reduction in entitlement spending. My own view is on record for over two years: Boomers, Prepare to Fall on Your Swords (June 2005)

Unfortunately, taxpayers will be fighting a two-front war, as hundreds of thousands of public employees have been promised retirement benefits and medical care coverage which is simply unaffordable without gargantuan tax increases and the slashing of other local government spending. As the public unions prepare to defend their entitlements with strikes, the public can only fight back by "throwing the rascals out" who try to raise taxes, and by refusing to cave in to the blackmail of public-union strikes.

5. Unprecedented bubbles in all asset classes. Stocks, bonds, derivatives, real estate, art--you name it, it's in a bubble. Interestingly, the best returns of the stagflation years were made in precious metals (a hedge against inflation and a dropping dollar) and plain old cash, which was eventually earning 15% per annum in money market accounts.

The root cause of all financial panics and depressions is of course runaway borrowing/skyrocketing debt, risk and leverage. Is the U.S. economy heading for a Great Unraveling? This chart suggests there is no other possible outcome for a debt/leverage/risk expansion which now far outstrips the stupendous imbalances of 1929.

Thursday, July 12, 2007

What's Different Now

We often read about "how it's different this time," meaning that prosperity will never end because, well, for the first time in recorded history, the business cycle has been banished for good. There'll never be any more down, only up, never any hangover, just permanent good times, no retrenchment of debt, just ever more risk-free borrowing.

Well, the pundits got the first part right: it is different this time, but it's worse--much worse, than it ever was in the past. Here we have a little chart which guarantees certain financial doom for the U.S. Yes, this is the double-whammy which will bankrupt the nation just as surely as the sun rises in the morning: entitlements promised to 76 million Baby Boomers and out-of-control medical care costs.

This combination is rather like a fission and a fusion nuclear weapon. A fission bomb explodes when a radioactive isotope of uranium is pushed together at high speed; a fusion weapon greatly amplifies the destructive force of the fission chain reaction by wrapping an isotope of hydrogen around the fission bomb. The spray of radioactivity from the fission causes the hydrogen atoms to fuse into helium, releasing tremendous energy in the process.

The staggering unending rise in all healthcare costs is like the fission bomb; now wrap 76 million people hungry for their entitlements and you get a thermonuclear destruction of the Federal budget and the U.S. economy. That's 25% of the entire U.S. population, and they start qualifying for Social Security in 2008 (1946 + 62), and for Medicare in 2011. Roughly 4 million more people per year are going to be tapping the Federal revenues from 2008 through 2029.

Rising healthcare costs threaten our entire economy as it is;We spend far more, but our health care is falling behind; Australia, Canada, Germany, New Zealand, U.K. spend less and do better job, studies say. It's become so well-known there's little more to say, but let's recap just how Third World our "healthcare" has become:

-45 million citizens lack any insurance or coverage-another 50 million have such minimal coverage it's practically equivalent to zero-we spend 15% of our stupendous $13 trillion GDP on "healthcare," compared to 10% for other advanced democracies who somehow cover their entire citizenry for 1/3 less expenditure-We don't have "healthcare," we have "sick-care":

"Ours is really is a sick-care system. We have tremendous technical capabilities to deal with people with serious illness," Thorpe said. He argues, though, that it is far more cost-effective to prevent people from getting sick or at least catch illnesses early through better monitoring."

This is not to say that thousands of hard-working people aren't doing their best to care for patients--they are. The point is: how does the system help or inhibit that care, and is all of the billing affordable to the individual and the nation as a whole?

If set out to design the worst system possible--horribly inefficient, dreadfully ineffective, astoundingly unfair, wasteful of resources, arcane in its bureaucracy, visibly unethical, stupendously corrupt and riddled with shameless profiteering, and larded with powerful disincentives to efficient care and egregious incentives for political meddling and profiteering by "providers" and drug pushers--this is the system you'd design.

But never mind all that, because we've run out of time to dither over details--our system will bankrupt us while we argue about how wrong Michael Moore is about everything. It doesn't matter if socialized medical care is horrible, too, or if the states are going to start their own plans (with borrowed money)--the whole ship is going down the moment foreign entities stop funding all our debt by buying most of our bonds.

Once we can't borrow enough to pay for it all--then we'll have to start dealing with reality.

As the marketing slogan has it: But wait--there's more! Yes, all our local governments are facing stunning increases in the healthcare and pension costs of their retirees. S.F. incurs huge costs for public retirees Governments begin to grapple with unfunded health care.

While a few municipalities are still reporting surpluses, the majority of state and local governments are facing pension and retiree healthcare increases which they have to fund out of tax revenues. In my neck of the woods, this "contribution" amounts to roughly 13% of the entire city budget: (and even higher in 2007) Pension Contributions Explosion Causes Berkeley Budget Woes:

"In 2005, $15 million of Berkeley’s $115 million general fund will pay for contributions to the California Public Employees System (PERS). Last year, the city spent $8 million on retirement benefits. The year before, when the state Legislature passed the bill that allowed Berkeley to improve the pension benefits, the city spent only $2.8 million.

Berkeley Police Lieutenant Sherrie Aldinger, who is retiring after 28 years on the job, will receive 84 percent of her highest annual salary from the city for the remainder of her life. The salary for a Berkeley Police Lieutenant ranges from $104,568 to $119,136."

So the city's pension contributions rose from $2.8 million to $15 million in three years, and there's no end in sight to the rise? Hey, I'm all for rewarding law enforcement officers, but couldn't they wait to 62 like the rest of us? And couldn't there be some cap on total retirement costs, including healthcare and "after retirement consulting" double-dipping?

The woes run even deeper if you look at the city payroll:

"Relative to the size of our population, the number of city employees is almost 3 times greater than other comparable East Bay Cities. Berkeley recently elected to purchase the 1947 Center Street Building at a cost of at least 28 million to house this ever increasing number of city employees. While Council members and staff publicly talk about a hiring freeze and a ban on overtime city departments continue to hire for replacements and even for new positions. Some employees who retire are also being rehired as consultants. They receive full pay through their pensions and also receive equivalent amounts or even more as consultants.

Is the new pension plan which guarantees retirement pay equal to 85% of top salary at age 50 for police and fire employees and 81% at age 55 for all other employees after 30 years of employment something that the city can afford? All employees also receive SRIP (supplemental retirement income pension) which is fully paid for by the city and they can voluntarily contribute to a third pension plan, similar to a 401K. With these three pension plans retiring employees, many of whom can choose to stop working in their fifties, will have a greater income during retirement for a period as long or longer than their time spent working for the city."

This is "real life" for public employees: a fatter paycheck in retirement than when they were working, and a pension longer than their work career. And please don't tell me how underpaid everyone is; there are plenty of schoolteachers and police officers in my extended family, and $65,000 for 9 months work is not underpaid. Low-skill clerks at UCSF make $45,000 a year; that's also not "low paid." They get their medical benefits for life after a mere 5 years of employment, as do all employees of the City of San Francisco.

Uh, can you spell "municipal bankruptcy"?

In the last standard-issue downturn/recession in the early 1980s, the nation did not face an avalanche of retirees, nor was it in the grip of runaway medical expenses. Municipal retirees received affordable benefits, not retirements in which they receive more than their working pay. The Great Bull Market of 1982 - 2000 enabled cities and states to pay retirement benefits out of rising stock and bond portfolios; now that easy gravytrain of wealth is ending.

Yes, it's different this time--but not in the way the cheerleading pundits blather about.

Wednesday, July 11, 2007

The Long Cycles of Prosperity, Decline and Upheaval

Back in April I discussed a new book by author Terence Parker titled The Rhythm of War in a civilized world . I thought so highly of Mr. Parker's insights and concise prose (the book is only 80 pages in length) that I posted a link to his site www.warcycle.com in my recommended list (right sidebar).

Please note that I receive no compensation from Mr. Parker should you buy a copy of his book.

Other observers believe we are approaching a 1929-type Depression, with the cycle before that beginning in the 1870s as the immense debts and stock market frauds perpetrated during the great rush into railroads collapsed and investors/speculators were wiped out.

Kondratieff's insights were based on deeply human causal factors: the way in which greed creates bubbles of speculative excess and wild risk-taking, and the manner in which the generation which recalls the hardships of Depression passes away, removing any living cultural brakes on the pell-mell rush to new speculative heights.

Mr. Parker adds another cycle to our understanding, one which he describes as swings from Nationalism to Individualism which pass through intermediate periods of "self and group." He supports this supposition with fascinating graphs of suicides and workers on strike, and identifies four points in the cycle: Realization, Self-Assertion, Self-Righteousness and Disillusion.

Lastly, he describes a cycle of violence, in which he identifies three general types of war: wars of domination, wars of creed, and wars of self-righteousness. Mr. Parker observes that wars of self-righteousness occur at the end of periods of rising prosperity; examples include the American Civil War, World War I and the Vietnam war.

Is there a better description of the Iraqi wars than this, a war of self-righteousness occurring at the end of a long period of prosperity? From the point of view of many, it is also a war of domination as well as a war of creed.

With these cycles in mind, I've drawn a little chart of various cycles which have recently reversed direction:

1. The Federal deficit After leveling off and actually declining in the late 90s years of Federal surplus, the deficit is approaching a staggering lift-off as baby Boomers start retiring in their tens of millions, tapping Social Security and Medicare entitlements.

2. Interest rates After falling for 22 years, rates have been rising for 3 years, which means there's only 15-20 years more to go before they top out.

4. Oil Notice how oil (adjusted for inflation) dropped for almost two decades, with a brief spike during the first Gulf War. Now it has been on a relentless rise since 2000, with no end in sight as the realities of Peak Oil/depletion start taking effect. Note what happened last time oil rose in price: stagflation, decline, recession, etc.

5. Greed/speculative fever There were periods of speculative excess/greed in the past 50 years--the "Nifty 50"/Go-Go years of the late 60s, and the "greed is good" (as long as the taxpayer ends up with the S&L bail-out bill, hahaha) years of the 80s, but nothing like the present near-infinite rise of bubbles in global equities, bonds, real estate, derivatives, artworks, you name it.

Want to get into the hot new real estate spot? Get thee to Mauritius, pronto! Hot new art field? Modern Chinese painters! Hot new furniture? Old school desks from the 60s! Yes, and you can find them right in your local school, because they're still there and in daily use! The textbooks are only 10-20 years old, so they're not yet collectable--but hey, you might be one of the first to score big if you start collecting them now.

When you can barely tell parody from reality, then the speculative bubble is about to burst. Exactly what in this chart supports the idea that the boom time is set to continue for decades to come? Let's see: crushing deficits, check. Rising energy prices, check. Rising inflation, check. Rising interest rates, check. Speculative greed/bubbles are off the charts, check.

When did all these conditions last occur? And what happened to the "permanent prosperity" of the 60s when they all changed course? It fell apart in a 15-year period of declining living standards, angst, stagflation and "creative destruction" of industries, livelihoods and wealth. Then all these negative trends reversed: money got cheaper every year for 20 years, oil dropped in cost for 20 years, etc.

Will deficits suddenly drop away? Really? With 60 million people retiring? Will oil suddenly plummet in price, even as super-giant fields are depleted and 2 billion more people aspire to middle-class lifestyles? Will inflation suddenly decline despite massive inflation of the global money supply? Will interest rates drop even as the dollar threatens to break down?

Bottom line: None of the trends essential to "permanent prosperity" have any likelihood of reversing their negative trendlines.

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